BRUSSELS: Two years ago, governments saved the necks of the world's financial markets. Yet today, those same markets intimidate governments, or at least some of them. In Europe, the market for Greek debt has frozen, and interest-rate spreads between Irish and German euro-denominated debt recently reached alarming levels. Spain has succeeded in reducing its own spread vis-à-vis Germany but only after a policy U-turn. Portugal has announced a major austerity package, hoping for the same effect. But, even when they are not in danger of losing access to the bond market, most governments in the developed world nowadays anxiously await the pronouncements of the same rating agencies that they were recently vilifying. This change of fortune is shocking. To public opinion, it looks as if arrogant financial-market professionals learned nothing from the crisis, feeding the impression that nothing has changed — except for the worse. Governments with a mandate to domesticate financial markets appear to have produced a lot of sound and fury, but little reform. Whether deliberately or not, regulators seem to have missed their chance to implement serious changes to the rules of global finance, and governments are now so weakened that they are at the mercy of those who, not long ago, were begging them for help. This politically devastating sentiment fuels resentment against markets and financiers. Nevertheless, while no one is proclaiming, “mission accomplished,” it is not true that nothing has been done to reform finance. In a recent study from the Brussels-based think tank Bruegel, Stéphane Rottier and Nicolas Véron provide a comprehensive scoreboard of the progress achieved in reforming financial regulation over the last two years, starting from the program agreed in November 2008 at the G-20 meeting in Washington. To be sure, they find that implementation has been patchy, with a gap between items whose follow-up was assigned to strong international organizations, such as the International Monetary Fund, and those merely calling for coordination among national authorities. Overall, however, the result is far from zero. Indeed, the US adopted wide-ranging financial reform in July, Europe is in the final steps of approval of its legislative package, and the Basel committee has just given the green light to a substantial tightening of credit-risk rules. The benchmark for this study is admittedly far from ideal. The G-20's Washington program (signed by George W. Bush) was neither ambitious nor well structured. It did not aim to domesticate global finance, and it was not based on a thorough analysis of the crisis. Under pressure to act without delay, and unable at this early stage to identify key priorities for structural reform, governments set themselves a long and ragbag to-do list. There was no sign of the more radical ideas that emerged later in the debate, such as the so-called Volcker rule separating banks and hedge funds (which is reflected in the US legislation), or a crisis-resolution mechanism whereby bank debt is converted semi-automatically into equity (which several countries are considering). Nor was there any mention of banks' size and ways to address the too-big-to-fail issue. Almost two years on, financial reform remains incomplete, as the agenda itself is still evolving. This was inevitable, because new, better-defined priorities could emerge only after a period of reflection and debate. The downside is that some momentum has been lost, especially at the G-20 level. The appetite for global solutions has diminished while national politics have taken increasing control of the agenda. But one positive recent development is the creation of stronger public institutions. The era when London vaunted its light-touch regulation is over. Now the US and Europe are in the process of building institutions capable of supporting — and implementing — sustained reform. Indeed, in pausing to reflect, governments have not missed the political opportunity to be tough, nor have financial markets regained the upper hand. True, the balance of power certainly is not what it was two years ago. Regulatory capture is at work again, perhaps even more forcefully, because the stakes are higher. But it is not self-evident that governments' ability to regulate has been seriously harmed by their status as borrowers. While Greece has virtually forfeited its access to capital markets, Germany has never borrowed on better terms. And, if governments' dependence on bond markets' willingness to lend has not rendered them unable to reform financial regulation, this is all the more true for the EU and the G-20. Just as we have learned to distinguish between governments as shareholders and as regulators — which must be done carefully, because the actions of one do not necessarily coincide with the interests of the other — today we must distinguish between governments as borrowers and as financial regulators. It would be unfortunate if governments requiring financial institutions to be more prudent in managing risk were at the same time asked to turn a blind eye to sovereign risk. Even if this sounds unfair, it is logical to expect rating agencies, which had been lax in evaluating credit risk, now to be rigorous in assessing all forms of risk, including sovereign risk. The history books are not yet written, nor the victor declared. Financial reform could still go belly up. But it is premature to write it off as a failure. Jean Pisani-Ferry is Director of Bruegel, an international economics think tank, Professor of Economics at Université Paris-Dauphine, and a member of the French Prime Minister's Council of Economic Analysis. This commentary is published by Daily News Egypt in collaboration with Project Syndicate, www.project-syndicate.org.
